Blockchain Byte R3 Research Emily Rutland The Blockchain Byte features a question from the distributed ledger space What is the distinction between a blockchain and a distributed ledger? Blockchain has a While often used interchangeably, a blockchain and a shared and replicated distributed ledger are distinct – though subtly different – technologies. ledger comprised of information stored in A distributed ledger is a record of consensus with a “blocks” and sits below cryptographic audit trail which is maintained and validated by several separate nodes*. This a distributed ledger cryptographically assured and synchronized data can be and acts as a way to spread across multiple institutions. Distributed ledgers can verify transactions be either decentralized, granting equal rights within the submitted by protocol to all participants or centralized, designating producing a new certain users particular rights. Actors typically employ “block” to the chain. distributed ledgers when they need a tool which permits the concurrent editing of a shared state while maintaining its unicity. The ledger’s state is determined through a Distributed ledger is a consensus algorithm, which can vary in its mechanics but record of consensus ultimately serves to validate information from inputs to the with cryptographic network. audit trail maintained and validated by nodes. It can be decentralized or centralized. For more Blockchain Byte posts, R3 members visit: 2 https://r3-cev.atlassian.net/wiki/x/HgEwAw What are Blocks and Why Aren’t They Necessary? Often described as the technology that underpins the Bitcoin network, a blockchain data structure has a shared, replicated ledger comprised of digitally recorded and unchangeable data in packages called blocks. A blockchain sits below a distributed ledger and acts as a way to order and validate the transactions in the ledger. While a blockchain automatically produces a new “block” after certain predetermined criteria is met, a distributed ledger only verifies a transaction once it is submitted, as opposed to pushing out empty blocks. A blockchain is a way to implement a distributed ledger, but not all distributed ledgers necessarily employ blockchains. *In a distributed ledger, it is not necessarily the case that all nodes either receive all the information or, if they do, can understand it. In the Ethereum model, for example, all nodes receive and understand all the information. In Corda, only the nodes involved are aware that a transaction exists. For more Blockchain Byte posts, R3 members visit: 3 https://r3-cev.atlassian.net/wiki/x/HgEwAw What are Blocks and Why Aren’t They Necessary? Proof-of-Work groups A block structure allows for global broadcast of data and transactions into large amounts of unrelated transactions to be confirmed at once. While blocks make sense for public blockchain blocks and broadcasts systems like Bitcoin, this logic does not apply to trusted it to unrelated parties. distributed ledger networks used within financial institutions, like Corda. Therefore, blocks are A “block” is a bundle of transaction data*. Most closely not suitable for use in a associated with Bitcoin, a blockchain structure connects trusted distributed blocks such that each block includes the hash value of the ledger network previous block, thereby forming a chain of valid between financial transactions. institutions. “Miners” create new blocks by validating transactions through a Proof of Work (PoW) exercise. This PoW exercise allows anyone (without permission) to create valid blocks if they can expend the required computing power (calculating hashes). This resource-intensive process also creates a financial barrier to deter malicious actors from adding fraudulent blocks. For more Blockchain Byte posts, R3 members visit: 2 https://r3-cev.atlassian.net/wiki/x/HgEwAw What are Blocks and Why Aren’t They Necessary? This PoW system deliberately takes time both to prevent arbitrary coin generation (which would lead to hyperinflation of the currency) and to prevent too many solutions at a given time (once a miner finds a solution, it must propagate around the network, which takes time and may lead to collisions and forks). In Bitcoin, this interval is an average of 10 minutes. To accommodate for this delay, transactions must be batched together and confirmed in blocks. In trusted, private distributed ledger networks, PoW and global broadcast of transactions are not necessary - it does not make sense to group unrelated transactions into blocks that are then shared with many, unrelated parties. Those private blockchain systems that do use blocks most likely use the Bitcoin structure without considering why Bitcoin works the way it does. Corda is different. Recognizing that the block structure is a flawed design decision for financial services, R3 deliberately chose not to use blocks for Corda and its financial services clients For more Blockchain Byte posts, R3 members visit: 3 https://r3-cev.atlassian.net/wiki/x/HgEwAw What is the difference between a centralized and decentralized blockchain? In a decentralized A blockchain can be either centralized or decentralized. It network, anyone can is important, however, that decentralized not be confused with distributed. While a blockchain is inherently distributed transact on the ledger. (meaning that many parties hold copies of the ledger), it is Bitcoin’s network uses not inherently decentralized. mining and proof-of- Whether a blockchain is centralized or decentralized work to maintain the simply refers to the rights of participants on the ledger, and integrity of the ledger. is therefore a question of design. In a decentralized network, anyone can participate and In a centralized transact on the ledger. As a result, mechanisms must exist network, only known in order to combat the vulnerabilities that arise from this and identified parties design and to ensure that transactions are correct. Bitcoin, can transact on the for example, is a decentralized blockchain that uses ledger. Therefore, their mining and proof-of-work* to maintain the integrity of the ledger and to prevent people from corrupting the system. transactions can be audited. A centralized network, on the other hand, is made up of parties whose identities are known. Thus, the system is valid because only credible and reputable participants can post to the ledger. Because participants’ identities are known, their transactions can therefore be audited. For more Blockchain Byte posts, R3 members visit: 2 https://r3-cev.atlassian.net/wiki/x/HgEwAw What is the difference between a centralized and decentralized blockchain? Ultimately, a centralized distributed ledger should be used in any highly regulated industry - such as financial services - to minimize vulnerability. While both decentralized and centralized blockchains have respective risks, a centralized network is much preferred for our purposes in that the identity of participants is known and, as a result, an audit trail exists should an actor attempt to corrupt the system. It is preferable, for example, to fine a known entity that entered an invalid transaction rather than attempt to account for every possible manipulation that could potentially occur in an anonymous, decentralized network. *Proof-of-work: a function to deter denial of service attacks and other potential spam on a network by requiring some level of work that is usually costly and time- consuming. In the Bitcoin network, miners must complete a proof-of-work in order to regulate the rate at which new blocks are generated. For more Blockchain Byte posts, R3 members visit: 3 https://r3-cev.atlassian.net/wiki/x/HgEwAw What is Central Bank Digital Currency? Central Bank Digital The concept of digital currency precedes distributed Currency is a digitally ledger technology. It began as a way to distinguish between Internet versions of digital money (i.e. DigiCash, stored currency that eCash) and electronic cash that existed on physical theoretically can platforms (i.e. Chipknip and Mondex) and grew more achieve real time complex with the advent of web platforms that provided settlement for access to accounting (i.e. Paypal). These examples are all individuals and banks. private market currency solutions that do not involve a central bank. CBDCs are intended Though the concept of a Central Bank Digital Currency to be issued by the (CBDC) remains largely theoretical, the evolution of new central bank and able technologies such as DLT is increasing the feasibility of putting a CBDC into practice. At a high level, a CBDC is a to exchange for fiat digital store of value (money) and method of exchange currency. It can also issued by a central bank. Theoretically, a CBDC introduces be an alternative to a new digital mechanism for real-time settlement between current market individuals. currency. For more Blockchain Byte posts, R3 members visit: 2 https://r3-cev.atlassian.net/wiki/x/HgEwAw What is Central Bank Digital Currency? CBDCs are intended to be 1:1 exchangeable with other forms of money (such as notes, coins and deposits at banks). They may be issued in an alternate form exchangeable for fiat currency that is held on deposit by a central bank and payable on demand to the owner. CBDCs can also be issued as a new form of money supply in addition to traditional central bank money issuance. One of the main purposes of a CBDC is to broaden access to central bank liabilities (such as notes and coins) in digital form, thus increasing the ease and convenience required to hold and pay these liabilities. In addition to broadening this access, a CBDC system must also be designed to be practically functional (for example, it cannot only be accessible through proprietary networks such as SWIFT or Fedwire). For more Blockchain Byte posts, R3 members visit: 3 https://r3-cev.atlassian.net/wiki/x/HgEwAw What is a Digital Signature? Digital signature A digital signature is a method to verify the authenticity authenticates the and integrity of a digital message. integrity of data by Digital signatures employ asymmetric (public key) using asymmetric cryptography, a cryptographic system that uses a pair of cryptography.